Blatantly speaking, when a company makes money (revenue), it doesn’t get to keep all of it. There are many different types of costs and expenses that have to be deducted from the firm’s revenue until the amount of cash that is left can finally be distributed and returned to the shareholders of the business at the end of the day.
The income statement lists out the income and expenses made by a firm within a given time period. Inside the financial statement, the process of how every single type of expense is deducted from the top line (revenue) can be tracked down right to the bottom, where the company’s net income or earnings are listed.
The concept of how an income statement is structured can be very helpful in understanding the difference between revenue and EBITDA because each line item represents the money that the company has generated at two different stages within the income statement.
What’s the Difference Between Revenue and EBITDA?
Revenue is the pure amount of money that the company generates from its operations without subtracting any costs associated with those sales while EBITDA is the revenue left after subtracting costs of goods sold (COGS) and some other operating expenses.
More accurately, EBITDA represents the earnings of a business prior to deducting interest, taxes, and amortization/depreciation.
EBITDA is a non-GAAP figure, which is why it doesn’t appear in most income statements. But If accountants would include EBITDA within an income statement, it would appear a few lines below the revenue line item. Conclusively, any EBITDA number of a given company will always be lower than its respective revenue figure as certain operating expenses such as COGS and G&A are deducted from it.
Analyzing Revenue and EBITDA serves different purposes. EBITDA is one of the many profitability measures that can be utilized in order to assess the efficiency of a company’s operations, while revenue solely represents the income generated by the business in the first place.
What Is Revenue?
Revenue or sales is commonly referred to as the top line within an income statement and represents the amount of money generated by a business from selling goods, products, and services. Since revenue reflects the raw income coming into a company, no costs and expenses aren’t subtracted from it yet which is why it can be located at the beginning of every income statement.
What Is EBITDA?
While EBITDA may look like a fairly unfamiliar term to some, it is also a profitability measure similar to net income or EBIT,
EBITDA stands for “Earnings Before Interest, Taxes, Depreciation, and Amortization”. Writing out the acronym explains exactly what EBITDA represents: It’s the earnings that a business has generated prior to any interest expenses, tax payments, and depreciation/amortization costs of the business.
As a consequence, EBITDA doesn’t reflect the actual net earnings of a business. Some companies can report a seemingly strong EBITDA in the first place while stating negative profits at the bottom line.
Here is an example of where EBITDA would be theoretically located within an income statement:
Revenue (Top Line)
(-) Cost of Goods Sold (COGS):
= Gross Income/Profit
(-) Operating Expenses such as G&A, R&D, and S&M excluding depreciation and amortization
In practice, depreciation and amortization expenses oftentimes aren’t listed as separate line items within the income statement. As a consequence, the better approach of calculating EBITDA would be to start at EBIT and then simply add back depreciation and amortization:
Why Do Analysts and Companies Use EBITDA?
EBITDA is primarily used to assess a company’s operational efficiency and financial performance. Some analysts, companies, and investors specifically prefer EBITDA over other metrics because it only measures the operational profitability of a firm: The costs that are deducted from revenue to calculate EBITDA are directly linked to the company’s operations and include, for example, rent, salaries, marketing costs, and research.
Capital structural decisions, on the other hand, aren’t directly associated with the operations of the business and result in financing, and capital expenditures, which are reflected as line items like depreciation, amortization, and interest expenses.
So the reason behind excluding such items is that they would have a distortionary impact as they do on other common profitability measures which makes it more difficult to compare the business with other firms.
As a result, using the EBITDA margin, for instance, allows investors and analysts to compare operational performances across companies with different capital structures.
EBITDA also has its downsides
- In many cases, EBITDA can be misleading because it doesn’t account for costs and expenses which can be crucial in assessing the financial performance of a business. Since EBITDA, is prior to taxes and interest expenses, any unhealthy debt decisions made by the company will be overlooked by just analyzing EBITDA.
- Investors and analysts may also often justify the negative company’s earnings by referring to the positive and often strong EBITDA metric which can turn attention away from a firm’s financial distress. Many investors also use the Price/EBITDA ratio in order to justify underpriced companies since it will mostly be lower than its ordinary P/E counterpart.
- Some people may also view EBITDA as a substitute for cash flows mainly because non-cash expenses such as depreciation and amortization are added back, which can be hazardous.
The difference between revenue and EBITDA lies in the fact that revenue reflects the pure amount of money that a business has generated from its operations while EBITDA is the revenue left after some operational expenses like COGS, G&A and S&M have been subtracted.
EBITDA is used by a considerably large group of investors, analysts, and companies as a more reasonable profitability and performance metric, primarily because it doesn’t account for non-operational expenses that are coming from financing effects and accounting choices.